Governor Signs Bill Regulating Retainage on Private Construction Projects - The New Retainage Law Bolsters the Mass. Construction Industry, Promotes Development and Improves Contractors' Cash Flows

by Holland & Knight LLP
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HIGHLIGHTS:

  • The new Massachusetts Retainage Law, which is similar to the Prompt Pay Law of 2010, will apply to any contract arising from a private construction project where the prime contract value is $3 million or more and for which a lien may be established.
  • Retainage shall be limited to 5 percent of each progress payment and new timing requirements apply to retainage release.
  • The new Retainage Law presents both opportunities and challenges for all parties in the industry. During the months before the effective date of Nov. 6, 2014, the industry will have the opportunity to digest the impact of the law; revise their standard contract forms to comply; and adopt new administrative policies, procedures and forms to be used in carrying out the requirements of the Retainage Law.

On Aug. 8, 2014, Gov. Deval L. Patrick signed into law "An Act Relative to Fair Retainage Payments in Private Construction." Massachusetts now joins numerous other jurisdictions in the regulation of retainage on private construction projects. The Retainage Law, as it is more commonly known, is codified into law at Mass. Gen. Laws Chapter 149, Section 29F. The new Retainage Law is a natural follow-on to the Prompt Pay Law of 2010, and represents the commonwealth's ongoing effort to:

  • support the construction industry's resurgence
  • promote development
  • improve the timeliness of cash flows for all contractors

History of the Massachusetts Retainage Law

The Associated Subcontractors of Massachusetts (ASM) first submitted a version of the Retainage Law in January 2011, just months after the Prompt Pay Law went into effect. Public hearings ensued in which the Associated General Contractors of Massachusetts (AGC) and various owner groups voiced concern over portions of the bill. In the spring of 2012, the Office of the Senate President urged all interested parties to work together to resolve outstanding differences.

ASM filed a modified bill in January 2013 and additional public hearings followed. The owner groups remained strongly opposed to the bill at that time. Between the summer of 2013 and late February of 2014, AGC's negotiating team achieved more modifications with ASM. By early June of 2014, AGC and ASM had reached agreement on all issues, which they submitted to legislative committees considering the bill. All parties provided final comments in an attempt to reach a fully agreed upon bill. While owner groups remained opposed to certain portions of the bill, it passed by wide margins in both houses. The governor signed the bill into law on Aug. 8, 2014.

The New Retainage Law: Key Provisions

The purpose of the new Retainage Law is similar to that of the Prompt Pay Law. Accordingly, both laws will apply in the same situation. Specifically, the new Retainage Law will apply to any contract arising from a construction project where the prime contract value is $3 million or more and for which a lien may be established under Mass. Gen. Laws Chapter 254, Sections 2 and 4.1

Cap on Retainage Withholdings
One of the most salient terms of the Retainage Law is a cap on retainage withholdings: retainage will be limited to 5 percent of each progress payment. No longer will owners or general contractors be allowed to withhold 10 percent or more to ensure performance.

Timing of Retainage Release
The new law also regulates the timing of retainage release. Timing requirements begin with thegeneral contractor's declaration of substantial completion, which itself is newly defined by the law as "sufficiently complete in accordance with the contract for construction so that the project owner may occupy or utilize the work for its intended use." The general contractor must submit a notice of substantial completion, in essentially the same form as specified in the new law, no later than 14 days from achieving the substantial completion. The project owner must then accept or reject the notice within another 14 days or else the notice is deemed accepted. The owner's rejection must be in writing and include the factual and contractual basis for the rejection. All of these new submissions and rejections must be certified in good faith by the tendering party and all rejections are subject to the dispute resolution provisions of the prime contract.2

Submission of Punch List
The owner must submit a punch list to the general contractor no later than14 days after acceptance of substantial completion. The punch list must identify both defective or incomplete work items and deliverables (project close-out documents as defined by the new law) required for final completion. In turn, the general contractor must compile a similar list for each subcontractor identifying those items on the owner's punch list applicable to the subcontractor and any other items the general contractor adds. The general contractor has an additional seven days to flow down to each subcontractor the list applicable to the subcontractor's work. As a result, each subcontractor would receive its specific list no later than 21 days from the owner's acceptance of substantial completion.3 Again, all punch lists must be certified in good faith by the tendering party.

Invoicing
Both the general contractor and subcontractors have the right to invoice retainage within 60 days of substantial completion. The request must include the punch list previously received and an indication that each item has been resolved (and in the case of deliverables, submitted). Retainage amounts must be paid by the owner within 30 days of the invoice. However, the owner can continue to withhold amounts, in the aggregate, for outstanding deliverables, incomplete or defective work items, and claims.4 General contractors will have an additional seven days to turn around retainage payments to a subcontractor, less the same categories of remaining offsets. This incentivizes prompt completion of final project obligations. Such offsets are only valid if the withholding party provides a written description, certified in good faith, of the outstanding issues or claims prior to the date the payment is due. Moreover, as long as the general contractor has not been declared "in default," a project owner cannot withhold retainage due to a trade contractor whose work is unrelated to the owner's claims against the general contractor.

It is important to note that conditional payment terms (i.e., "pay-if-paid" provisions) applicable to retainage are subject to the limitations of the Prompt Pay Law at Chapter 149, Section 29E, subsection (e). In addition, any contract provision requiring a party to delay commencement of an applicable dispute resolution provision more than 30 days after rejection of an application for retainage (or written notice of a dispute) is void and unenforceable.

Finally, the Retainage Law specifically states that a contract provision that "purports to waive, limit or subvert this section or redefine or expand the conditions for achievement of substantial completion for payment of retainage shall be void and unenforceable." While this provision will limit the parties' ability to draft around the express requirements of the law, there are various details affecting implementation of the law that can and should be addressed in construction contracts.

Impact on the Construction Industry in Massachusetts

The new Retainage Law presents both opportunities and challenges for all parties in the industry. Contractors of every tier can now benefit from additional – and more timely – cash flows that reduce risk and improve operations. Reduced risk for contractors theoretically means a lower construction cost for owners, particularly on lump sum projects. This promotes development and strengthens the opportunities for all players. Increased cash flow from monthly requisitions can also help avoid disputes. More cash flow could mean an easier path toward resolving disputed change orders mid-stream and/or an increased tolerance for project events that typically trigger disputes over additional time and compensation. This includes, without limitation, a subcontractor's typical obligation to resequence or amend its work plan without additional cost to the general contractor or owner. Only time will tell whether the retainage reduction, and the improved certainty provided by the timing requirements for release of retainage, will create benefits.

The law does create some additional risks. For instance, while parties in the paying position can withhold against retainage for "claims," that term is limited under the law as including only claims for breach of contract. That could expose upstream parties to paying retainage even though negligence or personal/property damage claims by third parties exist. Indemnity and other withholding rights of the upstream party could be potentially undermined. In addition, the owner community has expressed concern that lenders will continue to insist on (1) retainage higher than 5 percent; and (2) conditions precedent to the advancement of loan proceeds toward the end of the project that exceed the new statutory definition of substantial completion. Many large private projects are not financed through borrowing, but for those that are, owners and their counsel will need to be mindful of the new law when negotiating terms with lenders.

The statutory definition of the term "substantial completion" may also pose challenges. The term is defined as that point when the project is "sufficiently complete in accordance with the contract for construction so that the project owner may occupy or utilize the work for its intended use." Relative to laboratories, clean rooms, manufacturing facilities and other performance-based projects with multiple outputs, disputes could potentially arise relative to what is "sufficiently complete" to enable the owner's "intended use." The same could be said for a building that, while ready for use, is delayed in obtaining a certificate of occupancy (temporary or otherwise) for reasons beyond the parties' control. Moreover, some insurance coverages and warranties commence upon substantial completion, therefore both risk managers and counsel should closely monitor the industry's reaction to this new term.

Many of the concerns raised by the Retainage Law can undoubtedly be addressed through careful contract drafting, as long as the primary purpose of the law is not undermined or thwarted.

Time to Comply Before the Effective Date

The Retainage Law will become effective on Nov. 6, 2014, and will apply only to prime contracts entered into on or after that date, and subcontracts relating to these projects. During the months before the effective date, the industry will have the opportunity to digest the impact of the law; revise their standard contract forms to comply; and adopt new administrative policies, procedures and forms to be used in carrying out the requirements of the Retainage Law. Holland & Knight construction attorneys will be participating fully in programs designed to educate the industry about the new law.

Holland & Knight represented AGC in this matter.   

Notes

1 The Retainage Law does not apply to residential projects of one to four units.

2  The general contractor must commence dispute resolution, to the extent it exists under the prime contract, within seven days of any rejection.

3 The general contractor can expand the owner's punch list to subcontractors to the extent necessary.

4 Valuation of these remaining offsets is as follows under the new law: (1) deliverables (project close out documents) are as mutually agreed or not more than 2.5 percent of the adjusted contract price; (2) incomplete/defective work items are 150 percent of the reasonable cost to complete; and (3) claims are the reasonable value thereof and any costs, expenses and attorneys' fees incurred if permitted under the construction contract of the person seeking retainage release.

To ensure compliance with Treasury Regulations (31 CFR Part 10, §10.35), we inform you that any tax advice contained in this correspondence was not intended or written by us to be used, and cannot be used by you or anyone else, for the purpose of avoiding penalties imposed by the Internal Revenue Code.

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